| Once you register a corporation in your state, you | | | | The first problem is inadequate capitalization is one of |
| must go ahead and capitalize it. This raises a host of | | | | the biggest factors in setting aside corporate |
| questions regarding the best way to do it and potential | | | | protection under the theory of alter ego. If you form a |
| risks of getting it wrong. | | | | corporation and start turning multimillion dollar deals, a |
| First things first. Any discussion of capitalization needs | | | | $1,000 capitalization is not going to make a court very |
| a disclaimer. Every state sets forth its own rules on | | | | happy. As a result, it is vital that you evaluate your |
| capitalization and you should look to your state of | | | | capitalization in relation to the dollar value the |
| incorporation regarding them. These rules may cover | | | | corporation will be dealing with in contracts. You do not |
| issues such as minimum cash contributions that must | | | | want to lose the protection against personal liability |
| be made, debt to equity ratios and so on. | | | | provided by the corporate entity. |
| Capitalization is simply the funding of the corporate | | | | The second problem is the IRS. Yes, the IRS is always |
| entity. This is typically done through the sale of shares. | | | | a problem, but there is a specific reason here. The IRS |
| If a corporation has 100,000 shares, it might sell 20,000 | | | | does not like to see "thin" capitalization of corporate |
| of these shares to three shareholders. The question, | | | | entities. Why? Well, the payments on a loan are |
| of course, is for how much money? There is no easy | | | | deductible to the corporation. If those payments are |
| answer and there are issues to consider. | | | | reclassified as dividend payments, which the IRS will |
| Capitalizing a corporation is really a tax issue. There | | | | often do, the interest deduction for the corporation is |
| are advantages to loaning money to a corporation | | | | disallowed. Making matters worse, the loan |
| instead of directly capitalizing it. The primary advantage | | | | repayments to shareholders will be reclassified as |
| is the repayment of the loans from shareholders is tax | | | | dividend payments and additional taxes will be due |
| deductible to the corporation and places the | | | | from the time of the first payment on the loans. The |
| shareholders in a stronger position compared to other | | | | amendment of tax returns and payments of penalties |
| creditors should the corporation run into problems | | | | and interest will be required. |
| down the line. | | | | When you form a corporation, a careful evaluation of |
| Given the above, one might be tempted to capitalize | | | | the capitalization requirements of the entity needs to |
| the corporation at the minimum amount allowed by | | | | be considered. If it is handled incorrectly, it can come |
| your state, often $1,000 or so, and then just have the | | | | back to haunt you. Unfortunately, there is no bright line |
| shareholders loan the remainder of the start up money | | | | regarding the amount, so getting professional help is |
| to the corporation. This, however, can lead to problems | | | | often wise. |
| as well. | | | | |